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The Fed Extends and Pretends


Real estate mogul Sam Zell appeared on CNBC’s Squawk Box yesterday morning, devoting some of his time to the state of the commercial real estate market.

When asked why he didn’t swoop in to buy real estate road kill after the financial crisis, he said other than a few rare deals there wasn’t much to buy and still isn’t. He said there is no over supply of commercial real estate (although I’m not sure he’s taking into account all the redundant run-of-the mill strip centers and garden office buildings, perhaps he’s only talking about the multi-million dollar properties he would be interested in). Because interest rates have been zero, there hasn’t been the liquidation of real estate that would have taken place in a different interest rate environment.

In other words, the Fed has allowed the banks to extend and pretend, keeping zombie property owners in place forestalling the commercial crash. With no new commercial RE being built, as projects slowly fill up with tenants (at lower rental rates), Zell says the need for zombie tenants will go away, the banks will then foreclose and larger real estate companies will engage in “dilution is the solution deals.”

In Austrian Business Cycle terms, the Fed’s zero rates are forestalling the cleansing of the malinvestments (if not the buildings, the excessive leverage). Zell made millions buying properties for 20 cents on the dollar in the 1974-75 and 1990-91 real estate downdrafts. But this is a whole new Fed with a new bag of tricks.

Zell thinks this process has a couple years to go. But again, he doesn’t believe there is an oversupply of properties. In some markets there clearly is. So, for trophy skyscrapers maybe this all gets worked out in a couple years. For vacant retail and office buildings that are everywhere, maybe it takes decades.

Taking the other side of the argument is Jason Yablon at Cohen & Steers Inc. who says “Right now is a pretty good time to invest because we’re still at the beginning of the next stage of global real estate growth,” he said. “Valuations of global real estate are pretty good today, and we’re seeing a fundamental recovery around the world.”

However, Sam Zell wondered aloud with the Squawk Box crew whether anymore real estate needs to be built at all. Demand, he said, tends to fit into whatever supply is offered.


Doug French

Douglas French is former president of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply, and author of Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master's degree in economics from UNLV, studying under both Professor Murray Rothbard and Professor Hans-Hermann Hoppe.

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